In the early 2000’s interest rates were low and everyone bought more home than they could afford. When rates when up all of those balloons on mortgages came due with higher rates and the housing market collapsed. Today we are seeing a stock bubble based on low interest rates. What will happen to stocks when interest rates go up? Forbes interviewed the richest man in the world, Bill Gates. The co-founder of Microsoft says stocks are expensive but what bothers him is that interest rates are so low.
On Tuesday, Microsoft co-founder, Bill Gates, said “stocks are expensive” on CNBC. The bigger issue he raised was interest rates. Mr. Gates is amazed that interest rates have “stayed so low, for so long.” Mr. Gates said, “When do we go back to normal in terms of interest rates [and] multiples, there would be a lot of adjustment there.” Adjustment is a nice way of saying, stocks may sell-off. He also said, “Stocks are higher because of the interest rate environment.” That basically means that valuations have taken a back seat as Central Banks continue to their easy money policies.
The point is that low rates have driven an 8 year bull market in stocks and that is due to come to an end. Will the market calmly slow down or will it collapse?
Increasing Interest Rates
The U.S. Federal Reserve is due to raise rates, perhaps this month. And as economic conditions warrant they will keep raising rates. Many believe that their concern about extinguishing economic growth may be setting us up for a bigger fall when rates do go up. The Wall Street Journal says that the Fed is expected to raise interest rates.
Federal Reserve officials are likely to raise short-term interest rates when their two-day meeting concludes Wednesday, the only increase this year and just the second since June 2006. But what will they signal for the path of rates in 2017 and beyond? This will be the Fed’s first policy meeting since the election of Donald Trump, who has pledged tax cuts and new government spending-policies that could affect the Fed’s outlook for inflation and interest rates over time.
If the policies of the new Trump administration drive inflation higher the Fed will raise rates. The could be quite a bit if Mr. Trump’s version of supply side economics leads to a substantial short term boost.
What Does the Future of Trump and Higher Interest Rates Hold?
Forbes predicts that Trump’s plan will send the U.S. economy into the most severe recession since the 1980’s.
Long-term interest rate will continue to increase. Already, at the 2.5% vicinity it is a blow to a financial system long accustomed and addicted to much lower rates.
A strong and further strengthening dollar has severely unfavorable implications on exports and imports. In dollar terms, the U.S. is the world’s largest exporter reaching $2 trillion. The exposure and vulnerability the U.S. thus has is monumental.
Corporate tax cuts: It is inconceivable that a weakening economy will invest more just because corporations enjoy tax cuts and breaks. It is much more reasonable to assume that the corporate bond bubble of the last few years, used primarily for stock buy-backs and mergers& acquisitions activity, will be used to improve cash flow and debt repayment.
A combination of higher interest rates and poorly thought out economic policy by Trump may well send the market into a nose dive.